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Financial Reform Bill Becomes Law

Dennis Cuevas, Consumer Protection Counsel

Dennis Cuevas, Project Director and Chief Counsel, Consumer Protection

In an effort to prevent another collapse of the financial system and to avoid billion dollar bailouts of companies, such as AIG and Citi, Congress passed the largest overhaul of financial-industry regulation known as the Dodd-Frank Wall Street Reform and Consumer Protection Act (The Act). It includes a preemption provision to help states and expands the role of the state Attorney General. The bill was signed into law July 21 by President Obama.

The Act [P.L. 111-203] creates oversight for systemic risk posed by large, complex companies, products, and activities before they threaten the national economy. It changes the rules affecting the financing of business enterprises by creating a safe way to liquidate failed financial entities, and it imposes new capital and leverage requirements making it undesirable for companies to get too big. It also eliminates loopholes that allow risky practices to go on unnoticed and unregulated, including loopholes for over-the-counter derivatives and asset-backed securities.

It addresses governance and compensation by providing shareholders with a non-binding vote on executive compensation. It also provides strict rules for transparency and accountability for credit rating agencies to protect investors and businesses. Lastly, the Act provides for greater consumer protections.

Specifically, the new law creates the Bureau of Consumer Financial Protection (Bureau) as a new executive agency with very broad powers to regulate the consumer financial sector. The Bureau will assume most of the consumer protection functions of the Federal Reserve Board, Comptroller of the Currency (OCC), Federal Deposit Insurance Corporation, National Credit Union Administration, Department of Housing and Urban Development, and a few others. Excluded from the Bureau’s authority are persons regulated by the Securities Exchange Commission and the Commodity Future Trading Commission, as well as insurance, auto dealers, accountants, and tax preparers.

The Bureau will have broad rulemaking, supervisory, and enforcement powers over any person engaged in offering or providing a consumer financial product or service, as defined by § 1002(15). Examples include credit and loan servicing, brokering leases of personal or real property, deposit-taking activities, real estate settlement services, stored value and payment instruments, check cashing, check collection, consumer credit counseling, debt management services, and debt settlement services, among others. Banking organizations with assets of more than $10 billion will feel the greatest impact since the Bureau will have exclusive rulemaking and examination, and primary enforcement authority. Smaller banks will not escape the rulemaking authority of the Bureau, but will be mostly free of the Bureau supervision and enforcement authority.

The Federal Trade Commission (FTC) will lose authority to promulgate rules, issue guidelines, or conduct studies or issue reports under the federal consumer credit laws, but it will retain its authority to enforce the credit laws with respect to nonbanks. The FTC will share enforcement authority with the Bureau of the Truth-in-Lending Act, Equal Credit Opportunity Act, Fair Debt Collection Practices Act, and others over nonbanks.

The Act gives the Bureau authority to prevent covered institutions from engaging in unfair, deceptive, or abusive acts or practices in the provision of consumer financial products and services. It mandates that lenders verify mortgage borrower’s ability to repay the loan and requires lenders to consider credit card, income, and debt-to-income ratios in making loan approvals. The Act bans the payment of yield spread premiums or other originator compensation that is based on interest rate or other terms of the loans. It also bans certain loan provisions, including prepayment penalties and mandatory arbitration on mortgage loans.

The Act reduces the pricing threshold for a loan to qualify as a “high cost” loan subject to the restrictions in the Home Ownership and Equity Protection Act (HOEPA), and expands the definition of points of fees for calculating that threshold. It requires new Truth in Lending Act (TILA) disclosures on monthly mortgage statements and mandates notice on negative amortization prior to an initial ARM rate reset. The Act also amends TILA and the Real Estate Settlement Procedures Act (RESPA) to outline instances in which creditors must establish escrow accounts for payment of insurance and taxes on certain mortgage loans.

Preemption and the states

The Act enhances the role of the states in the regulation of federally chartered institutions and clarifies federal preemption of state laws. It establishes a new framework for federal preemption of state consumer financial laws by curtailing the OCC’s preemption authority. The OCC may preempt a state law only in accordance with the holding of the Supreme Court case of Barnett Bank of Marion County, N.A. v. Nelson, Florida Insurance Commissioner, et al., i.e., on a case-by-case basis and on the basis of “substantial evidence.” No preemption regulation or order by the OCC may be interpreted or applied to invalidate or otherwise declare applicable to a national bank, a provision of a state consumer financial law unless substantial evidence supports the finding. Furthermore, preemption authority is not granted with respect to subsidiaries, affiliates or agents of national banks that are not national banks themselves, contrary to the Supreme Court’s ruling in Watters v. Wachovia Bank, N.A.

It expands the role of state Attorneys General by clarifying the Supreme Court holding in Cuomo v. Clearing House Association, L.L.C. by stating that no provision of the National Bank Act relating to state visitorial authority may be construed so as to limit the authority of state Attorneys General to bring action to enforce any applicable law against a national bank. State Attorneys General may bring civil actions against national banks and federal thrifts to enforce the regulations prescribed by the Bureau under Title X, but not to enforce Title X itself. State Attorneys General may bring civil actions to enforce Title X or Bureau regulations with respect to any state-chartered entity. Any actions brought by state Attorneys General may be brought in a federal court or state court in the Attorney General’s own state.

In sum, Congress took action to address failures that led to the financial crisis. The new law is expected to restore responsibility and accountability in the financial system, and affirm the dual-banking system and all that it entails.

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